Lynn Strongin Dodds looks at the prospects for resuscitating a seemingly dead European CMBS market which had only one new successful issue this year
It was just a little over a year ago that market participants heralded the return of the European commercial mortgage-backed securities market (CMBS), which had been dormant since 2007. The euphoria was short lived and the market today is in need of resuscitation, unlike its US counterpart, which is showing signs of life. Future prospects do not look promising as investors remain wary of any deal tagged with the word securitisation.
Deutsche Bank did appear to be jump starting the market last summer with its £303m (€383bn) DECO 2011-CSPK issue, which securitised a single loan on the Chiswick Park business park in London that was acquired by US private equity group Blackstone. However, the euro-zone crisis came back with a vengeance and activity has been thin on the ground ever since. This year only one deal has been made: the £210m single-loan CMBS on Merry Hill, the UK’s third largest shopping centre, also issued by the German bank.
There had been hopes that the bank was set for the €1.16bn securitisation of German property group Vitus’ multi-family housing portfolio, but plans have been put on ice because its main buyer, JP Morgan, is dealing with the fallout from its $5bn (€3.9bn)-plus trading scandal. The US bank was thought to be providing up to 90% of the new senior debt to be issued as part of the refinancing.
Talk has also grown quiet over Royal Bank of Scotland’s plans to securitise £550m Project Isobel senior debt. The bank will only do the deal if the pricing is attractive relative to the 600bps margin with which it underwrote the loan, and the bank is currently thought to reviewing the situation.
It could prove challenging finding interested parties. “I would love to say that the European CMBS market is coming back, as it was the only liquid part of the real estate debt market,” says John Feeney, head of real estate debt at Henderson Global Investors. “I don’t think that will happen soon, and when it does it will not look like the CMBS transactions of the past where there were multi-loan conduits and very complex structures. The few deals in recent years have been based on a small number of properties and borrowers, and I think that is the only viable model.”
Phillip Burns, CEO of private equity group Corestate Capital, agrees. “One of the main problems today is that there are limited natural buyers for the paper, because it is not generating enough yield - for those who previously levered the cash flows to make them attractive - or there is residual fear,” he says. “Looking ahead I do not see new CMBS as real mechanism for getting things solved because the buyside market is not there.”
Long-term CMBS spreads have widened on the back of low interest rates and are more than four times the level in November 2007, while relative yields on European commercial mortgage debt has narrowed 135bps to 440bps this year, according to figures from JP Morgan.
The lack of enthusiasm is prompting market participants to think again about how to tackle the mountain of debt due over the next five years. Industry estimates show that about €800bn of real estate debt is slated for refinancing in Europe over the next three years with around €150bn of loans estimated to be tied up in CMBS. There were hopes that securitisation would prove to be a possible exit strategy but that does not seem to be the case today.
In fact, all eyes are on the outcome of German residential company Deutsche Annington’s proposals to refinance Europe’s largest securitisation, the €4.46bn Grand CMBS. It was structured at the height of the 2006 heyday after Guy Hand’s private equity vehicle Terra Firma acquired the company a year earlier. The plan includes a €504m equity injection from sponsor Terra Firma, a five-year bond extension in return for higher coupons, an amendment of the documents for a solvent scheme of arrangement and also the ability to refinance the portfolio in chunks - rather than in one jumbo pool. About €10bn of German multi-family CMBS is due to mature in 2013, of which Deutsche Annington represents slightly less than half.
The German residential property market has proved to be one of the safest in Europe during the financial crisis, and if the restructuring is successful it would mark a coup for Terra Firma, which could be a significant step towards an eventual flotation of the company. It is far from a done deal; the plan could face stiff opposition from some bondholders who are thought to want better pricing. They object to the increase in margin from 48bps to 165bps, because it does not reflect the current market rate, which is closer to 225bps.
“The workout process has become complex because the CMBS deals done in the 2004 to 2007 boom years were much more complicated,” says Roger Barris, founding partner at Peakside Capital. “Last time we had a major downturn in the real estate markets, most of the lending was bilateral and easy to unwind. The situation is different today because the CMBS deals we are looking at have many borrowers with different interests. This creates conflicts of interest and makes for a more laborious and ponderous process.”
Whatever the result in the Deutsche Annington case, the halcyon days when the market reached its £100bn peak are not expected to return. The Commercial Real Estate Finance Council Europe’s recent recommendations restore credibility, but it will not help fuel activity.
Paul Lloyd, head of loan servicing at CBRE, says: “CREFC Europe has been pivotal in the compilation of the CMBS 2.0 market principles. Various experts across the market have been involved in the drafting to ensure as many legacy issues have been captured and dealt with where necessary. They aim to instil confidence back into a somewhat fractured product, where improvements in areas such as transparency, x-class and special-servicer replacements, among other notable areas have been discussed.”
James King, director, fixed Income at M&G Investments, says: “I don’t think we will ever get back to where we were in 2007. We are not seeing those types of volumes. There is some origination in the US, but only at the right market conditions. It is not happening here and instead we are seeing the emergence of a private debt market which is a shame in some respects because it is not as liquid as the public market.”